Friday, 26 February 2010

Equalization - theory and practice

Today's National Post highlights a nice piece of work by Winnipeg's Frontier Center for Public Policy showing equalization is well to the right of the relevant Laffer curve. In theory, Canada's equalization system taxes rich provinces so that poorer provinces can enjoy social services comparable to those in richer provinces. Those who appreciate Tiebout competition recoil in horror, of course: workers should move to the province offering the best bundle of taxes and services, so the system attenuates incentives for government efficiency. I've seen the argument made that equalization reduces inefficient migration, as though it's somehow better that folks stay unemployed in Newfoundland rather than move to Alberta; I don't buy it.

Frontier's work shows that donor provinces - Ontario, Alberta, and British Columbia - have lower average levels of access to public services than the provinces that they help to support. If the point of equalization is to provide equal access to these services, then it's engaging in far too much redistribution.

This is perhaps an inevitable long term consequence of basing equalization payments on provincial GDP rather than on an actual baseline measure of service provision. If we have heterogeneous preferences across provinces on the ideal size of government and if at the relevant Canadian margins more government disproportionately means lower growth (I'm looking at you, here, Quebec), then the provinces that choose smaller government / high growth are effectively forced to subsidize the preferences of other provinces' voters. That seems ridiculous. It's almost as bad as taxing the hard-working especially heavily to compensate folks who want to enjoy more leisure...oh, wait....

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